Madoff Suit Costs JPMorgan Chase & Co. (JPM) $2.6B

by Zacks Investment Research on January 8, 2014

In a further resolution of its legal issues, JPMorgan Chase & Co. (NYSE:JPM) agreed to pay nearly $2.6 billion to settle several charges pertaining to lapses in reporting suspicious activities at Bernard L. Madoff Investment Securities LLC (BLMIS). Following this announcement, the company’s share price fell during intra-day trading due to negative investors’ sentiments. The company’s share price closed at $58.32 on Jan 7, down 1.2% from the previous day.

Madoff had accounts with JPMorgan more than two decades before being arrested in 2008 for running a Ponzi scheme that duped investors of billions of dollars. The penalty of $2.6 billion is related to the bank’s settlement with various governmental regulators as well as other private parties to resolve civil litigation related to BLMIS.

As part of the settlement, JPMorgan Chase & Co. (NYSE:JPM) entered in to a Deferred Prosecution Agreement (DPA) with the U.S. Attorney’s Office for the Southern District of New York, under which the U.S. Attorney will defer any prosecution of JPMorgan for a two-year period. Hence, the company agreed to pay $1.7 billion to the government as a non-tax-deductible payment.

Additionally, under the terms of DPA, JPMorgan admitted the allegations leveled against it, namely its failure to maintain a proper anti-money laundering program. Further, the company violated the Bank Secrecy Act as it did not file a suspicious activity report (SAR) in the U.S. in Oct 2008 with respect to BLMIS.

Further, the Financial Crimes Enforcement Network slapped JPMorgan Chase & Co. (NYSE:JPM) with a penalty of $461 million for not detecting and reporting suspicious transactions related to BLMIS. However, this amount is not required to be paid as the company is already making similar payments to the U.S. government.

Moreover, JPMorgan will pay $350 million as Civil Money Penalty to the Office of the Comptroller of the Currency (OCC) in connection with various Bank Secrecy Act/Anti-Money Laundering deficiencies.

Separately, JPMorgan will pay $325 million to the trustee appointed by the court for BLMIS. This will absolve the company of all claims that could crop up from transfers received directly or indirectly from BLMIS. Also, the company will make payments of $218 million to the class action plaintiffs for exchange for a release of all damages claims related to BLMIS. Both these settlement amounts (subject to court approvals) will be distributed to BLMIS fraud victims.

Though significantly reserved to meet the financial terms of the settlement, JPMorgan Chase & Co. (NYSE:JPM) will likely be adding $400 million (pre-tax) of litigation reserve when it announces the fourth quarter results on Jan 14. Notably, the settlement will lower the company’s fourth-quarter net income by $850 million as the settlement amount is non-tax-deductible.

Notably, JPMorgan had set aside nearly $9 billion to cover legal costs in the third quarter. This had led the company to report a rare loss 17 cents per share in the said quarter.

Despite having settled the Madoff case, we believe that JPMorgan Chase & Co. (NYSE:JPM)’s run-in with regulators and other investigation agencies will likely continue in the near term. The company continues to face roughly eight government probes. Hence, higher litigation costs continue to weigh on the company’s performance, going forward.

With the announcement of this settlement, the Madoff trustee will be recovering more than $10 billion or 59% of the total amount lost, for victims. However, the trustee is still pursuing claims worth roughly $3.5 billion from UBS AG (US listing) (NYSE:UBS), HSBC Holdings plc (ADR) (NYSE:HSBC) and UniCredit SpA, all of which have been accused of benefiting from the Madoff fraud.